Dealing with a liquidity trap when government debt matters: optimal time-consistent monetary and fiscal policy
AbstractHow does the need to preserve government debt sustainability affect the optimal monetary and fiscal policy response to a liquidity trap? To provide an answer, we employ a small stochastic New Keynesian model with a zero bound on nominal interest rates and characterize optimal time-consistent stabilization policies. We focus on two policy tools, the short-term nominal interest rate and debt-financed government spending. The optimal policy response to a liquidity trap critically depends on the prevailing debt burden. In our model, while the optimal amount of government spending is decreasing in the level of outstanding government debt, future monetary policy is becoming more accommodative, triggering a change in private sector expectations that helps to dampen the fall in output and inflation at the outset of the liquidity trap. JEL Classification: E31, E52, E62, E63, D11
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Date of creation: Dec 2013
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Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
- D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-05 (All new papers)
- NEP-CBA-2014-04-05 (Central Banking)
- NEP-MAC-2014-04-05 (Macroeconomics)
- NEP-MON-2014-04-05 (Monetary Economics)
- NEP-PBE-2014-04-05 (Public Economics)
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